Flash Comment US: gradual manufacturing slowdown continues

• The ISM fell less than expected to 55.5 in July, but the headline masked weaker details as both the production and new orders indices deteriorated further

• The details of the report as well as our fundamental analysis continue to point to further slowing in manufacturing sector growth in the coming months.

• The main scenario remains a moderate slowdown, with the ISM reaching around 53 by year-end. This is usually consistent with GDP growth around trend.

Details

The details of the report were generally softer than suggested by the headline, with the forward-looking details weakening further.

The new orders and production indices both dropped to the lowest level since July 2009.
Although the indices remain close to their historical average, any decline from the current level will increase the risk that economic growth is heading below trend.

The indices for manufacturers’ as well customers’ inventories increased. While the customers’ inventory index remains around historical lows, the index for manufacturing inventories has now moved into the upper end of its historical range.

In any case, the orders’ inventory balance in today’s report suggests that a further slowdown in the growth rate for manufacturing production is in the pipeline. While the more volatile ‘new orders’ vs. ‘inventory’ balance produces a relatively negative signal, the more reliable ‘new orders’ vs. ‘customers’ inventories’ balance indicates a more moderate slowdown.

On a positive note, the ‘new export orders’ index stabilised around 56. While this is below the recent highs, it remains consistent with relatively solid growth in US real exports at around a 10% annualised rate. The imports index dropped to 52.2 – the lowest level since late 2009. The composition of the import/export index indicates that net exports (which subtracted 2.8pp from annualised GDP growth in Q2) will be less of a drag in H2.

Outlook and assessment

Going forward, we expect a further slowdown in the manufacturing sector. The big questions are how fast the manufacturing slowdown will arrive, and whether the labour market will be able to recover sufficiently in the coming months to support the transition from a stimulus/inventory-driven recovery to a demand-driven recovery.

The fundamentals continue to suggest that a moderate manufacturing slowdown is the most likely outcome. Firstly, real manufacturing inventories of finished goods are still declining, leaving few signs of overshooting in manufacturing production. This is consistent with our hard-data inventory-demand ratio, which continues to slow, but remains in moderate expansionary territory. On top of this, financial conditions have improved lately, with equities recovering and credit spreads narrowing. Our ISM models indicate a year-end level around 53.